Good morning,

Markets are called to open flat this morning. This is what's happening today:

  • Agricultural Bank of China Ltd. and China Unicom (Hong Kong) Ltd. posted lower-than-expected earnings, underscoring concerns about economic growth in the nation after a report yesterday signalled manufacturing output may slow for a fifth month;
  • More than half of Asian companies that reported earnings since January have missed analysts’ estimates;
  • Spain’s most populous region votes in two days in an election that may give Prime Minister Mariano Rajoy’s People’s Party free rein to enact his deficit-cutting policies;
  • Spain's 10-year yield has increased to 5.49% from below 5%;
  • Italy's 10-year is now yielding 5.096%;
  • Eurozone PMI hit 48.7 for the March flash estimate, a 3-month low, with German and France slipping back below 50, missing estimates. Germany Manufacturing PMI is at 48.1, a 4-month low, and France manufacturing PMI dropped to 47.6, also a 4-month low;
  • The HSBC/Markit China Manufacturing PMI dropped to 48.1 after rising for 3 months, hitting a 4-month low;
  • Apple closed the session at $599.34 (after hours $598.35) and $711.99 (after hours $711.50)

Markets came down yesterday after PMI data for France, Germany and China slipped below the 50 level. The DAX closed 1.3% lower whereas the S&P500 closed 0.72%. There is alot happening in the markets and alot can be said to explain this reaction. The DAX, NASDAQ and NIKKEI are all up 18% since the start of the year. Alot of people are making more profits than they were expecting to make for a whole year. Now we get some negative PMI data and these investors think it is the right time to exit the market. You can't blame a trader to want to take some profits if he is +20% up in just 3 months. Though what's interesting to see is why the PMI data came in back below the 50 level. And alot of it has to do with an external shock, that is the increase in oil price with Brent hovering around the $123.23 level and the price of gasoline above $4 a gallon being unsustainable.

The high oil price is slowing production and this is more than understandable. But does it warrant a selloff in the markets? My opinion is no it doesn't. But like I said alot of investors who are short term traders are making more money in 3 months than they normally make in a whole year so if they cash in and sit on cash till the end of the year they are more than happy with their performance.

But the truth is for the investor who is looking for value, I take a contrarian view and think that being in this market is the best thing you could be doing. At this point in time things become trickier. Because from this point on not every stock will continue its momentum to the upside. Let's face it since the start of the year you didn't need to be a guru to make money. If you didn't know what you were doing and invested in the wrong sectors you probably still made money even if you underperformed the index. But going forward its not going to be that easy. Though there still is alot of money to be made. It all boils down to being invested in the right sectors and picking the stocks that will generate the highest alpha.

I am not too concerned about the oil price at this point in time because we have seen Saudi Arabia come out and say that it will increase supply and the UK, France and the US said they will also increase supply of oil. Data so far shows that there is more than enough supply to cater for demand. It is the political risk that is driving the oil price to these levels. Though what's important is that there isn't a problem of supply. That would have been a real concern. Though since the high oil price is only sustained because of political risk, once the situation improves it would be only a matter of time before we see mean reversion in the oil price and see it back down to the $90/barrel level.

So lower PMI data because of a higher oil price doesn't worry me because I know that the decline came from an external shock. On the other hand what's interesting is that up to 30% of the 100 billion yuan ($15.82 billion) of Guangdong province's pension fund that will be managed by China's National Social Security Fund (NSSF) could be invested in stocks. Expectations are running high that Beijing is about to unveil landmark reforms to create China's own version of the U.S. 401K pension savings programme, to allow funds managed by local governments more freedom to invest in a wider range of assets, including domestic equities. Now this is interesting news which should increase demand for equities and push prices up.

I've been through the 40 page document where Goldman Sachs make their point that it is time to shift out of bonds and into equities. In a nutshell this is what they say. Bonds have outperformed equities over the last 25 years because of the high Equity risk premiums which were used to calculate valuation models after the Great Depression and Credit Crunch plus we had periods of disinflation between the 1980s and 1990s which resulted in lower bond yields.

Basically Goldman Sachs do not agree with the high equity risk premium factored into valuation models leading to lower intrinsic values. They don't believe that margins will start to fall and that even if we see a slowdown in growth, margins will be maintained through improved technology. Goldman are predicting an average global growth rate of 4.3% in the 2010-19 decade.

Some investors are worried that developed markets will follow the faith of the Japanese markets in 1989 which lead to 20 years of depression. This is not the case because the situation in developed markets is different today. When the Japanese market crash started in the late 1980s, companies were trading on PE ratios as high as 80x! Furthermore, ROE in Japan was low even before the bubble burst in the late 1980s and has been low ever since compared to the US and Europe. European stocks are trading on a PE of 13x not 80x!

Another reason why treasuries are overbought is because China is a major holder of US paper. The demand puts yields down though once they move out of treasuries in order to inject more money into their economy, yields will start coming up.

So the conclusion is that the ERP used in valuations is too high and companies are trading below their intrinsic value. Money will move out of treasuries into riskier assets and the developed world will not follow the faith of the Japanese economy – plus ROE in the developed world is higher than it was in Japan in the 1980s. A positive note on Japan is that we are finally starting to see an improvement in the economy, and with the weakening Yen boosting exports, Japan too is worth looking into.

Stock to watch: Terna S.A. (Eur3, Price Target E3.30)

Terna is a fully regulated company operating in electricity transmission in Italy. Terna's new business plan is a good combination of sustained visible CFs, a seek for increased returns and financial flexibility in its B/S. RAB and NI growth in its traditional activities into 2016 will be of 6%. The 19 E cents announced DPS floor represent for a 6.5% yield and allows room for upside in our view. Capex of E 2bn into non traditional activities look profitable with a 15% return and will further drive NI growth. Net debt/RAB should be at 52% in 2016, in line with regulatory assumptions. Present DPS payout of 95% will drop to below 70% by 2016 on traditional activities and has clear room for upside in our view. With ~10% upside to TP and a 6.5% dividend yield, Buy.

For further information on Terna or other stocks we follow contact our offices on 25688688.

Good day and happy trading!

Kristian Camenzuli